The impact of the Doha round of WTO agricultural negotiations on the South African economy

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(1)The impact of the Doha round of WTO agricultural negotiations on the South African economy. by. Bonani Nyhodo. at University of Stellenbosch Thesis submitted in partial fulfilment of the requirements for the degree of Master of Science in Agriculture (Agricultural Economics) at the University of Stellenbosch. Department of Agricultural Economics Faculty of AgriSciences. Supervisor: Prof Nick Vink March 2009.

(2) DECLARATION By submitting this thesis electronically, I declare that the entirety of the work contained therein is my own, original work, that I am the owner of the copyright thereof (unless to the extent explicitly otherwise stated) and that I have not previously in its entirety or in part submitted it for obtaining any qualification.. March 2009. Copyright © Stellenbosch University All rights reserved. i.

(3) SUMMARY The Doha Round of negotiations on the liberalisation of agricultural trade inherited complications from its predecessor - the Uruguay Round (UR). It needs to be noted, as one of the fundamental differences, that agriculture sectors in the developed countries of the Organisation for Economic Co-operation and Development (OECD) get support from their governments. In contrast to the situation, in the developing countries, agriculture is taxed to generate government revenue. The subsidies that farmers receive in the developed countries affect farmers globally through world prices (world prices depression). Therefore protection and greater subsidies should be not encouraged. As such, after a long time of preferential treatment, agriculture trade was tabled as a separate issue of negotiations at the UR and resulted to the round to be prolonged. However, one of the achievements of the UR was imposing of bound tariffs on agricultural products and determining tariff equivalence for non-tariff measures. Then, the Doha Round (DR) also known as the Doha Development Agenda (DDA) which is the first round to place development and focus strongly on agricultural liberalisation as a tool for development. International trade theory supports agricultural liberalisation, as negotiated in the DDA. Therefore, the DDA, in seeking more liberalised agricultural markets, continues a theoretically sound approach, as in the UR. The effects of liberalising agricultural trade in the DDA will differ across countries, whereas some will gain, others may loose, and the same situation is true for different sectors within an economy. The focus of the DDA on agriculture, as a tool of development, links well to the fact that agriculture in the developing countries accounts for a substantial share of their gross domestic products (GDPs) and exports. This situation, therefore, calls for a closer consideration of the possible impact of agricultural liberalisation in South Africa even though agricultural share of GDP is less than 4 percent. Consequently, the objective of this study is to reveal the impact of liberalising agriculture trade on the OECD countries to the welfare of South Africa. Liberalisation of the OECD countries agricultural and food commodity trade was simulated assuming a reduction of import tariffs, the tax rate on factor use and export subsidies organised in terms of four steps of 25% points each. The initial changes in world prices were taken from a global model called GLOBE. Results from this model were used to calculate the weighted average world prices that South African producers are to face. Those weighted average world prices were used as a policy shock to the PROVIDE model.. ii.

(4) The results of the study show that the changes in world prices from the OECD’s proposed liberalisation (75 percent liberalisation) of agriculture and food commodities prices range between 19.6 and +3.8 percent for imports, and between -3.0 and +29.7 percent for exports. The results show that South Africa would respond positively to world price changes, with government and macro variables showing minimal but positive responses.. iii.

(5) OPSOMMING Die Doha Rondte (DR) onderhandelings rondom liberalisering van handel in landbou produkte het verskeie komplikasies geërf van sy voorganger, die Urugauy Rondte (UR). Een van die fundamentele verskille tussen ontwikkelende en ontwikkelde lande wat binne die Organisasie vir Samewerking en Ontwikkeling (OECD) val is dat landbou bedrywighede tipies in laasgenoemde lande gesubsidieer word. In teenstelling word landbou bedrywighede in ontwikkelende lande tipies belas en dien dus eerder as ‘n bron van inkomste vir regerings. Die subsidies wat boere in ontwikkelde lande ontvang plaas afwaartse druk op wêreldpryse tot nadeel van boere reg oor die wêreld. Om hierdie rede behoort beskerming deur mate van subsidies afgeraai te word. Dus, na ‘n lang tydperk waar landbou voorkeur behandeling geniet het, het handel in landbou produkte ‘n afsonderlike item op die agenda geword by die UR, wat toe ook daartoe gelei het dat die onderhandelings langer geduur het as verwag. Een van die belangrike uitkomste van die UR was egter dat tariefgrense op landbou produkte gehef is. Ekwivalente tariewe is ook vasgestel vir nietarief maatstawwe. Die DR, ook bekend as die Doha Ontwikkelings Agenda (DOA) wat gevolg het plaas ‘n groter klem op liberalisering van handel in landbou goedere as ‘n manier om ontwikkeling te bevorder. Internasionale handelsteorie is ten gunste van landbou liberalisering soos in die DOA onderhandel. Die DOA sit dus die prosesse van die UR voort op ‘n gesonde teoretiese grondslag. Die impak van landbou liberalisering verskil van land tot land, met sommige wat sal baat vind daarby en ander wat verloor. Dieselfde geld vir sektore binne ‘n land. Die DOA se fokus op landbou is belangrik, aangesien hierdie sektor dikwels ‘n groot bydrae tot bruto binnelandse produk (BBP) maak in ontwikkelende lande. Alhoewel landbou slegs 4 persent bydrae tot die BBP in Suid-Afrika, is dit steeds belangrik om die impak van landbou liberalisering te ondersoek ook vir hierdie land. Die doelwit van hierdie studie is om die impak van handelsliberalisering in landbou in OECD lande te ondersoek, spesifiek met die oog daarop om te bepaal wat dit inhou vir welvaart in Suid-Afrika. Verskeie simulasies is uitgevoer om die impak van ‘n verlaging in tariewe op landbou- en voedsel kommoditeite te bepaal, asook die effek van verlagings in wêreldpryse as gevolg van laer vlakke van beskerming in ander lande. Laasgenoemde simulasies is gebaseer op resultate van die GLOBE model wat elders gebruik was. Die impak op Suid-Afrika word gesimuleer met behulp van die PROVIDE model.. iv.

(6) Die resultate dui daarop dat liberalisering in OECD lande (75 persent liberalisering) op landbou- en voedsel kommoditeite beteken dat wêreldpryse met tussen -19.6 en +3.8 persent kan verander vir invoere, en met tussen -3.0 en +29.7 persent vir uitvoere. Die resultate wys verder dat Suid-Afrika positief reageer op hierdie veranderinge in wêreldpryse, met regerings- en makroekonomiese veranderlikes wat op klein maar positiewe resultate dui.. v.

(7) ACKNOWLEDGEMENTS Each moment of life will never be repeated, and for that reason, I feel obliged to use this opportunity to convey my appreciation to the following people and organisations whose contributions to the completion of this thesis have been of immeasurable importance. •. Prof Nick Vink, my supervisor, thank you for the confidence and support that you have given me since I joined your department. Thank you, too, for accepting the role of being my supervisor and for the insight that you have given me into the nature of world agricultural negotiations.. •. My mentor, Cecilia Punt, for the determination and support that she has lent to the project at all times, as well as to all the other members involved in the PROVIDE project (especially Melt van Schoor and Kalie Pauw).. •. Dr Scott McDonald, for developing the GLOBE model, which enabled me to ascertain world prices.. •. The Young Professionals Programme (YPP) of the Western Cape Department of Agriculture and the Department of Agricultural Economics at Elsenburg for their valuable motivational support, as well as Dr Dirk Troskie who was acting as Director of Agricultural Economics section of the Department.. •. The following people deserve to be acknowledged for their brotherly/sisterly advice in all areas of life and their support of my interest in becoming an agricultural economist: Dr ASM Karaan; Mrs B Matoti, Mr M Mjonono and Mr BM Gilimani.. •. I feel humbled to say thank you to all of my family members for the emotional support that they have given me during the course of this study.. •. The Ou Huis housemates and YPP of 2004–2006: Mr Bhiya Clovis; Ms Chue Kedibone; Mr Mashabela Tebogo, and Mr Mentani Phumlani. Thank you all for the key advice that you have given me.. vi.

(8) TABLE OF CONTENTS DECLARATION ............................................................................................................................. i SUMMARY ................................................................................................................................... ii OPSOMMING ............................................................................................................................... iv ACKNOWLEDGEMENTS ........................................................................................................... vi LIST OF TABLES AND FIGURES ................................................................................................ x LIST OF ABBREVIATIONS ........................................................................................................ xi CHAPTER 1: INTRODUCTION .................................................................................................... 1 1.1. Background ........................................................................................................................ 1. 1.2. Motivation and problem statement ..................................................................................... 3. 1.3. Research question .............................................................................................................. 4. 1.4. Methodology ...................................................................................................................... 4. 1.5. Model limitations and strengths .......................................................................................... 6. 1.6. Outline of the study ............................................................................................................ 7. CHAPTER 2: TRADE THEORY AND IMPORTANCE OF AGRICULTURE .............................. 9 2.1. Introduction........................................................................................................................ 9. 2.2. The basis of trade liberalisation and its challenges ............................................................ 10. 2.2.1. Trade theories ............................................................................................................ 10. 2.2.2. Shortfalls of free trade theories .................................................................................. 13. 2.2.3. Strengths of free trade theories ................................................................................... 13. 2.3. Adjustments to trade liberalisation (free trade) ................................................................. 15. 2.4. The potential effects of trade liberalisation on developing countries ................................. 17. 2.5. The role of agriculture in the development of the poor...................................................... 17. 2.6. Conclusion ....................................................................................................................... 18. CHAPTER 3: THE SEQUENCE OF AGRICULTURAL NEGOTIATIONS OF THE WTO ........ 19 3.1. Introduction...................................................................................................................... 19. 3.2. Agricultural trade negotiations before the Uruguay Round ............................................... 20. 3.3. The effects of the special treatment of agriculture............................................................. 20. 3.4. The three major areas of agricultural negotiation within multilateral trade ........................ 21. 3.4.1. Domestic subsidies in the UR ..................................................................................... 21. 3.4.2. Market access in the UR ............................................................................................. 23. 3.4.3. Export subsidies in the UR ......................................................................................... 24 vii.

(9) 3.4.4. Special and Differential Treatment (SDT) of the UR ................................................... 25. 3.5. The Doha Round of multilateral trade negotiations ........................................................... 26. 3.6. Selected countries’ positions on the pillars of the DDA .................................................... 27. 3.6.1. South Africa ............................................................................................................... 27. 3.6.2. The United States of America ..................................................................................... 28. 3.6.3. The European Union .................................................................................................. 29. 3.7. The group of 20 developing countries............................................................................... 29. 3.8. The July 2004 framework agreement (on the three pillars) of the DDA ............................ 30. 3.9. The Hong Kong Ministerial Declaration of the DDA ........................................................ 32. 3.10 The collapse of the DDA and possible way forward ......................................................... 34 3.11 Conclusion ....................................................................................................................... 36 CHAPTER 4: APPLICATION OF THE MODEL ......................................................................... 38 4.1. Introduction...................................................................................................................... 38. 4.2. Model application – deriving the shock from a global model ............................................ 39. 4.3. The GLOBE model (multiregional or multi-country model) ............................................. 39. 4.3.1. Dataset ....................................................................................................................... 39. 4.3.2. Shocks ........................................................................................................................ 40. 4.3.3. Closures ..................................................................................................................... 41. 4.3.4. Results ....................................................................................................................... 42. 4.4. A single-country model (the PROVIDE model)................................................................ 42. 4.4.1. CET for exports and CES for imports and their behavioural relationships.................. 44. 4.4.2. Transaction relationships ........................................................................................... 48. 4.4.3. Price and quantity systems ......................................................................................... 52. 4.4.4. Closures rules set in the PROVIDE model .................................................................. 55. 4.5. The data ........................................................................................................................... 56. 4.6. Method of adapting the GLOBE model’s results for PROVIDE model ............................. 57. 4.7. Conclusion ....................................................................................................................... 58. CHAPTER 5: DISCUSSION OF THE PROVIDE MODEL RESULTS ........................................ 59 5.1. Change in the world price of exports and imports (GLOBE model results) ....................... 59. 5.2. The PROVIDE model results ........................................................................................... 60. 5.2.1. Effect of world price changes on domestic prices and quantities................................. 60. 5.2.2. Producer effects ......................................................................................................... 62. 5.2.3. Effects on agricultural production .............................................................................. 62 viii.

(10) 5.2.4. Other commodity prices and factor relocation ............................................................ 63. 5.2.5. Factor relocation ....................................................................................................... 64. 5.2.6. Household income and expenditure ............................................................................ 64. 5.2.7. Employment and wage effects ..................................................................................... 65. 5.2.8. Total factor income .................................................................................................... 67. 5.2.9. Macroeconomic and government effects ..................................................................... 67. CHAPTER 6: CONCLUDING REMARKS AND RECOMMENDATIONS................................. 70 6.1. Introduction...................................................................................................................... 70. 6.2. Answers to the research questions .................................................................................... 70. 6.2.1. The impact on world prices of agricultural commodities ............................................ 70. 6.2.2. The effect on agricultural production ......................................................................... 71. 6.2.3. The degree to which households stand to benefit from such change and factor returns 71. 6.2.4. The likelihood of growth in the economy due to the liberalisation of agricultural trade ................................................................................................................................... 71. 6.2.5. The likely responses of the South African labour market ............................................. 72. 6.3. Conclusions...................................................................................................................... 72. 6.4. Recommendations for further research ............................................................................. 73. REFERENCES ............................................................................................................................. 74 APPENDICES .............................................................................................................................. 81 Appendix 1 ................................................................................................................................ 81 Appendix 2 ................................................................................................................................ 82 Appendix 3 ................................................................................................................................ 83. ix.

(11) LIST OF TABLES AND FIGURES Tables Table 4.1: Simulations of liberalisation ................................................................................ 41 Table 4.2: Macro SAM for the model ................................................................................... 43 Table 4.3: Behavioural relationships for the model ............................................................... 47 Table 4.4: Transaction relationships for the model ............................................................... 50 Table 5.1: Changes in factor income (at 75% liberalisation) ................................................. 67 Figures Figure 4.1: Price relationship for a model ............................................................................. 53 Figure 4.2: Quantity relationship for a model ....................................................................... 54 Figure 5.1: Wheat and sugar price effects (PM, PE, PQD and PXC) ..................................... 61 Figure 5.2: Wheat and sugar quantity effects (QE, QM, QQ and QXC) ................................ 62 Figure 5.3: Value added during agricultural activities at 75% liberalisation .......................... 63 Figure 5.4: Commodity price effects at 75% and 100% liberalisation ................................... 64 Figure 5.5: Changes in per capita household income and consumption ................................. 65 Figure 5.6: Employment (FS) effect at 75% and 100% liberalisation .................................... 66 Figure 5.7: Government and macroeconomic effects at 75% liberalisation ........................... 68 Figure 5.8: Government and macroeconomic effects of agricultural liberalisation ................ 69. x.

(12) LIST OF ABBREVIATIONS AoA. Agreement on Agriculture. CGE. Computable general equilibrium. CPI. Consumer price index. DDA. Doha Development Agenda. DR. Doha Round. EU. European Union. GAMS. General algebraic modelling system. GATT. General Agreement on Trade and Tariffs. GDP. Gross domestic product. LDC. Least developed countries. OECD. Organisation for Economic Co-operation and Development. SADC. Southern African Development Community. SAM. Social accounting matrix. SDT. Special and differential treatment. SSG. Special safeguard mechanism. TRQ. Tariff rate quota. URAA. Uruguay Round Agreement on Agriculture. WTO. World Trade Organisation. xi.

(13) CHAPTER 1: INTRODUCTION 1.1. Background. Under the General Agreement on Trade and Tariffs (GATT), agricultural trade negotiations have always fallen under trade in goods. However, agriculture received special treatment. The preferential treatment that agriculture received secured its prevalent status as one of the highly protected or subsidised sectors of world trade. Attempts to address this situation came during the Uruguay Round (UR), where agricultural trade was tabled separately from trade in goods (Indikadahena, 2005). Consequently, the UR of negotiations is regarded as a historical turning point in agricultural negotiations. These agricultural negotiations resulted in one of the celebrated achievements of the UR: the conversion of all non-tariff barriers into their tariff equivalent, a reduction in applied tariffs and the setting of bound tariff levels (Hertel, Anderson & Martin, 2000). The UR was followed by the Doha Development Agenda (DDA) that was launched in 2001 and the ninth round of World Trade Organisation (WTO) negotiations (Fisher, 2006). In its declaration market access, domestic subsidies and export subsidies were tabled as the three pillars of agricultural negotiations to negotiate. However, Stiglitz & Charlton (2004) argue that the development of developing countries should form the basis of the DDA. Their stance was affirmed by Hertel & Keeney (2007), who argue that the DDA emphasises development and focus on agricultural liberalisation inspired developing countries. The focus on agricultural trade liberalisation and development raised the expectations and hopes of developing member countries. However, the labelling of the DDA as developmental round caused concerns as to whether the round was going to be beneficial to developing countries (Stiglitz & Charlton., 2004). The developed countries, on the other hand, in affirming their commitment to development, made further promises that the round would indeed be beneficial to the developing countries. The European Union (EU) promised to abide by the principles of development (Oxfam briefing note, 2003). Furthermore, liberalisation of agricultural trade was highlighted to have the ability to reduce poverty in poor countries (Oxfam briefing note, 2003). Agriculture accounts for more than 60% of the gross domestic product (GDP) of these countries, employs more than 60% of their labour force, represents a major source of their foreign exchange, supplies the bulk of their food and provides income for a large percentage of the rural population (Amani, 2004). However, in. 1.

(14) South Africa, agriculture accounts for about 3% of the GDP, 7.7% of employment and 7% of total exports (Vink, 2003). Given the value of agriculture in developing countries (measured in real GDP terms), liberalisation of agriculture will have pronounced effects on developing countries. Hertel & Keeney (2005) argue that the general effect of liberalising the three pillars of agricultural negotiation1 will vary. Net exporters will gain while net importers will lose (unless they become net exporters in the course of adjusting to the new conditions). It is expected that liberalisation of agricultural trade would, therefore, encourage the demand for developing countries’ products, thereby increasing their export prices, which would, in turn, result in improved terms of trade. However, the elimination of preferential markets will force the beneficiaries of these policies, which include South Africa, to face tough competition from other exporters. Such a situation could erode demand for the exports of developing countries, resulting in the deterioration of terms of trade (Hertel et al., 2000). Viewing the two possible implications of world trade, it is important to look at the effect of possible liberalisation of agricultural trade without eroding the preferential market access. Liberalisation of agricultural trade could cause the integration of the agricultural sector into the world trade economy. This could be either beneficial or detrimental for producers, because the economies of scale will ultimately determine the potential gainers or losers (Foster & Valdes, 2004). Consumers will then face price increases for certain products and decreases for others. In many developing countries, policy makers will face the challenge of finding instruments that could cushion the impact of liberalised trade on both domestic producers and consumers (Foster et al., 2004). Prices of agricultural commodities are expected to increase. The effect of agricultural trade liberalisation will come through changes in world prices. At the time of commencing this study (2005), the world prices of agricultural and food commodities were depressed. It is argued that the complete liberalisation of agricultural trade in the DDA will cause an aggregate increase of almost 12% in the world price of agricultural commodities, relative to an index of all prices (Shapour & Trueblood, 2003). Therefore, the removal of all tariff rates will result in an 11% increase in world prices, while the removal of all domestic support will cause a 30% increase in the world prices of agricultural products. The agricultural subsidies and protection given by developed countries are the primary cause of low agricultural prices and account for 80% of the depression of world prices of 1 These pillars are market access (reduced tariffs), domestic subsidies (reduced tax rate on factor use) and export. subsidies (reduced export support). 2.

(15) agricultural and food products (FAPRI, 2002). FAPRI further highlights that the world prices of oilseed will increase by 3.1%, cotton by 15%, dairy by a massive 27–34%, wheat by 4.8% and maize by 5.7% under full liberalisation of all trade distortions. This increase in world prices will come about because of a reduction in outputs, and outputs will decrease as support is reduced in the subsidising countries. This, in turn, will lead to a reduction in supply to the world market, which will result in prices being pushed up, as countries will no longer have excess supply to export. The impact of world price increases on developing economies is important to note. It is also important to note that the distribution of gains from the DDA is complex. It is argued that the greater share of the forecasted rise of US$355 billion in global income by 2015, because of trade liberalisation, will go to the developed countries of Western Europe rather than to the developing countries of the Southern Hemisphere (Stiglitz et al., 2004). South Africa may gain or lose because of agricultural liberalisation as negotiated in the Doha Round.. 1.2. Motivation and problem statement. During the Uruguay Round, economic forecasts showed that benefits from that round were to go to developing countries. In 2004, Stiglitz et al (2004) argued that about 70% of benefits from the Uruguay Round went to the developed countries and the remaining 30% went to export-oriented developing countries. Despite the disappointment from the previous round, at the ministerial launch of the Doha Round in 2001, developing countries’ expectations rose again as the round was said to focus on issues of development and was even labelled as the Doha Development Agenda (DDA). One of the areas of interest to developing countries, agricultural liberalisation, was put at the core of negotiations. However, the Doha negotiations have not been smooth. A conflict of interest emerged on what was to be tabled at Cancun and the Singapore issues between developed countries of the OECD and a group of developing countries known as the G-20. These differences continued until the Doha Round was even labelled to have collapsed in 2006. Despite all the complications and expectations of the negotiations, interest of what the DDA possible mean to South Africa especially liberalisation of agricultural trade in the developed countries of the OECD is vital. This study serves as one of the first studies to use the PROVIDE model to assess the impact of the DDA on the South African economy. This will also contribute to the innovative and increasing literature on model-based assessments of the impact of the DDA on reform proposals. Some of these papers include those by the FAO 3.

(16) (2002); the OECD (2002); Poonyth, Sharma and Konandreas (2004); and Stiglitz and Charlton (2004. Although the list of works in this area is growing, none has focused on South Africa. The challenge facing South Africa is whether the agricultural outcomes of the DDA will benefit its economy. The problems identified require that the present study focus on enhancing the value of information that can be used in formulating South Africa’s agricultural negotiating position, which should benefit South Africa as a whole.. 1.3. Research question. The central question that this study seeks to address is whether the South African agricultural sector stands to benefit or suffer losses from the current round of negotiations on agriculture. Moreover, what would the gains or losses be and what would they entail? This core question can be further divided into the following questions: •. What is likely to happen to the world prices of agricultural commodities if agricultural trade is liberalised in the OECD countries?. •. What is likely to happen to agricultural production in South Africa?. •. Does the average household stand to benefit from the potential outcomes, and if so, what is likely to happen to factor returns?. •. Would the South African economy grow or decline due to the liberalisation of agricultural trade?. •. 1.4. How is the South African labour market likely to respond to this scenario? Methodology. The model2 used for the analysis is a computable general equilibrium (CGE) model, which is a computer-simulated model of the economy. The model is a numerical one, based on general equilibrium theory. It is capable of presenting a holistic view of the entire economy as a web of interrelated activities consisting of seven different types of agent: commodities, activities, factors, households, government investment or savings, enterprises and rest of the world. Such a model allows for the consideration of a two-way trade flow, assuming that both foreign and domestic products are but imperfect substitutes. The CGE models are a class of models with the defining characteristics of endogenising all transactions and flexible relative 2 The model used to analyse the results of this study is the PROVIDE model. However, another model was used. in another study to derive the policy shock used to shock the PROVIDE model and that model is the GLOBE model. The GLOBE model was developed and applied by McDonald et al (2007). It is a global model that runs in GAMS and is based on the GTAP dataset. 4.

(17) prices. All CGE models are price responsive in that shocks to the system and changes in policy cause changes in the price signals to agents, which, in turn, necessitate changes in patterns of production, consumption and trade (McDonald & Punt, 2004). Consumer and producer behaviours are based on the neoclassical economic assumption that consumers maximise utility, subject to budget constraints, while producers simultaneously maximise profits, subject to the technology available to them. The CGE models are comprised of the production, consumption and trade of a country or can be multiregional in nature, with the latter accommodating the consideration of interregional economic links (Mabugu & Chitiga, 2004). Utility maximisation generates a product’s demand function, and when the labour supply is not fixed exogenously, the labour supply function can have an effect through increasing employment or number of persons employed. The CGE models organise the economy into markets and it is assumed that all markets are in equilibrium and that the quantity supplied equals the quantity demanded, constituting a general equilibrium. The interdependence of markets means that the prevalent price in one market enters the supply and demand functions of the other markets. Such interdependence allows for the relative complexity of the CGE models compared with the partial equilibrium models, which only focus on one market while taking the environment as a constant, in accordance with the ceteris paribus assumption (Gilbert & Wahl, 2002; Mabugu et al., 2004). The CGE models, specifically the PROVIDE model, are based on a social accounting matrix (SAM). The SAM serves to identify the agents present in the economy and provides a database for calibrating the model. The success of the SAM in portraying the desired outcomes depends upon its grouping of agents in terms of behavioural relationships. The SAM traces all transactions between agents in the economy, it uses a factor-use matrix to identify the quantities of each different factor by each activity for the period to which the SAM refers (PROVIDE, 2006). The SAM, the factor-use matrix and the elasticities are the three separate sets of data that are used collectively for modelling purposes. The SAM uses a supply-and-use structure that allows for the possibility that all activities can produce multiple products, which is indeed the case for all activities in the SAM. According to the PROVIDE SAM, agricultural activities should refer to regions of the country that should, ideally, be agronomic in nature, whereas the agricultural census data are organised according to magisterial regions. An agronomic classification of agricultural activities implies a number of issues. Firstly, it implies that every agricultural activity can 5.

(18) produce a range of commodities. Secondly, it implies that land should be used for a specific form of agricultural activity, without the possibility of alternative use. Finally, it implies that the probability of farming for all agricultural activities depends on the effect of policy shocks, which are felt across the ranges of the commodities’ output prices. This paper uses data arranged into two groups: a SAM that records all transactions that take place between agents in the economy and a series of elasticities that control the model’s behavioural functions. The full explanation of the PROVIDE SAM for South Africa is available in the PROVIDE technical paper, 2006. The SAM for this study has 28 commodities (consisting of 11 agricultural and 6 food commodities); 28 activities (consisting of 10 agricultural and 6 food activities); 41 factors consisting of gross operating surplus (GOS) known to be capital, land and 31 labour factors; and 32 different types of household. The full list of SAM accounts for this study is provided in Appendix 3. The study focuses on the treatment of agricultural activities; however, the SAM that was used applies to all activities, including the production of multiple products.. 1.5. Model limitations and strengths. As appealing and influential as models are, they suffer from a number of weaknesses that are recognised in the published literature. However, these weaknesses are usually overlooked in practical application, and such oversight can potentially lead to inaccurate conclusions being drawn with regard to policymaking. The CGE can thus be criticised on several accounts: •. Firstly, the model is based on the assumptions of neoclassical economics, which are sometimes unrealistic. In addition to this, the model is based on the assumption of utility and profit maximisation.. •. The second problem is that there are no missing markets. Though prices are the main drivers of economic activity, in reality, there are no markets and, hence, no price adjustments for phenomena such as environmental quality and social cohesion. Such factors, however, constitute an important impact through their influence on human behaviour (Shoven & Whalley, 1992).. •. The third problem is that CGE models have convex production technologies, which rule out increasing returns to scale. This problem is a real-world phenomenon that plays an important role in technical changes (Arthur, 1994).. 6.

(19) •. Lastly, there is a concern that the underlying theory itself focuses on equilibrium and disregards the fact that equilibrium can be unstable and is a situation that is difficult to reach and maintain (Ackerman, 1999).. However, the CGE model is still regarded as a powerful tool for simulating an economy, for numerous reasons. Where assessing the impact of trade on many agents in the economy is required, many modellers regard this model as the best tool to use, for the following reasons: •. Since the model accommodates detailed economic data and is capable of tracing indirect effects, it allows for the distribution of policy impacts over different groups of the population and takes into account a number of different variables, including occupation, race and income.. •. The model is multisectoral and in many cases multiregional, which implies that it covers a whole range of sectors and that the behaviour of economic agents is modelled.. As has been explained in previous sections of this chapter, the research undertaken in this study is very necessary in terms of the South African economy. The analytical tools and CGE models used in this study are believed to be the best available and most suitable tools to answer the research question and subquestions posed in this study. The limitations of the analytical tools have been discussed and it was shown that the CGE models suffer from a number of weaknesses. However, the discussion of their strengths justifies their use rather than the use of other models, such as the econometric model, which may be useful in addressing other research questions. To achieve the object of this study clearly and sequentially, an outline of the study is presented in the following section.. 1.6. Outline of the study. This structure of the study is as follows: •. Chapter 2 reviews free trade and its associated critique. It also reviews the importance of agriculture to the economies of developing countries, with specific reference to South Africa.. •. Chapter 3 analyses the WTO agricultural negotiations until the collapse of the DDA.. •. Chapter 4 presents a detailed explanation of the research methodology used in this study. 7.

(20) •. Chapter 5 presents a discussion and analysis of the research results.. •. Chapter 6 presents the conclusions and recommendations of the study.. 8.

(21) CHAPTER 2: TRADE THEORY AND IMPORTANCE OF. AGRICULTURE 2.1. Introduction. International trade theory provides some of the information required for agricultural trade negotiations at a multilateral level. Trade literature comprises theories that are in favour of free trade as well as those that are against it. This leads to the need for an analysis of the agricultural trade liberalisation policy of the WTO. Trade literature suggests that liberalisation is necessary but under certain circumstances protection is justified. The literature thus recognises the protection of infant industries as a necessary policy option (Lindert & Pugel, 1996). Sound international trade theory, be it of a protectionist or free trade nature, can clearly provide valuable information in support of informed decision making at negotiations on agricultural trade. Free trade, or trade liberalisation, can result in developing countries not benefiting from negotiated outcomes if policy adjustment mechanisms do not exist because a movement from existing circumstances to free trade may cause structural changes. It is also important to recognise the role of agriculture in the economies of developing countries such as South Africa because this will lead to sensitivity in the handling of negotiations. Agriculture contributes more than 60% to the GDP in developing countries although in South Africa, it contributes only approximately 3%. Agriculture also contributes significantly to employment and foreign exchange earnings (Amani, 2004; Vink, 2003). Therefore, if trade policy decisions are based on misleading3 information or wrong perception, developing countries could be adversely affected. In an attempt at verifying whether free trade or trade protection is the best possible option for developing countries, the formulation of an objective for this chapter became clear. Hence, the objective of this chapter is to uncover the attributes of trade liberalisation, or free trade, and to link them to the importance of the agricultural sector, with specific reference to the South African economy. Accordingly, this chapter provides a critique of free trade as well as possible ways of benefiting from liberalisation. It also considers the overall role of agriculture.. 3 Portrayal of either free trade or protection as the only policy option of socio-economic value.. 9.

(22) 2.2. The basis of trade liberalisation and its challenges. Ackerman (2001) argues that economists have fought the battle for and against free trade on all levels. This implies that certain economists are in favour of free trade while others are against it. The battle has been fought along the lines that free trade is a desirable policy measure that will enable all countries (developed or developing) to improve their welfare. At the centre of the dispute are complex economic arguments. These economic arguments are based on assumptions in which other assumptions are said to be unrealistic. In defence of these arguments, Shafaeddin (2000) argues that trade theorems do not suggest that free trade is the best policy option. Trade theorems argue that free trade is better than no trade, given certain conditions. Shafaeddin (2000) also argues that free trade fails to recognise that the different stages of development of countries cause different reactions to changes in protection. Along the same lines, economists like Facchini & Willmann (2001) argue in favour of free trade and suggest that while its principles are clearly understood and respected by economists, the logic behind it is often misunderstood. They argue that free trade has an important role to play in income generation and distribution. However, their arguments suggest that competitive sectors will withstand competition from imports while uncompetitive sectors will lose due to import substitutes. The following section looks at classical theories of trade in order to analyse whether free trade or protection together with support do create a desirable environment. 2.2.1. Trade theories. The first international trade theory to acknowledge gains from the exchange of goods is the theory of absolute advantage,4 formulated by Adam Smith. It must be noted, though, that this theory compares an initial situation without trade to a situation with trade. However, this theory fails to address the existence of trade where one country has an absolute advantage in the production of two traded commodities (Lindert et al., 1996; Parrish, 2004). Immediately following the theory of absolute advantage was the theory of comparative advantage. The theory of comparative advantage developed an answer to the question that Adam Smith could not answer. In his theory of comparative advantage, David Ricardo developed the idea that trade patterns among countries should be based on relative efficiency rather than on absolute 4 The theory argues that certain countries produce certain goods more efficiently than others do and that this. advantage is absolute. Accordingly, it is postulated that a country should export those products in which it has an absolute advantage and import those in which it does not. 10.

(23) efficiency. According to this theory, even if a country has an absolute advantage in the production of two commodities, it still has a relative advantage in the production of one commodity over the other. This means that it should specialise in the production of that particular commodity. The theory further argues that the determinant of relative advantage is the relative productivity of labour (Lindert et al., 1996; Parrish, 2004). Since its introduction, the theory of comparative advantage has become a core concept in international trade literature and thought, and economists generally accept it as a valid viewpoint, regardless of the inherent weaknesses pointed out below. Despite the recognition that the theory of comparative advantage has received and its popularity, the theory makes an unrealistic assumption, even in its simplest form – the twocountry, two-commodity model. The assumption is that price determinants are relative to labour productivity only and have nothing to do with demand and supply, zero transport costs, the absence of trade barriers, the maximal use of resources or conditions of perfect competition (Parrish, 2004). The other weakness is that it accounts for only one factor of production and fails to explain the reasons behind the differing levels of labour productivity encountered in different countries (Parrish, 2004). This weakness is considered in the Heckscher-Ohlin (H-O) theory, which follows. The H-O theory agrees with and recognises the concept of comparative advantage introduced by Ricardo. However, the H-O theory postulates that a country will export a commodity that intensively exploits a factor of production that it has in abundance and will import a commodity that intensively uses its scarce resources. In extrapolating this concept, the Stolper-Samuelson theorem emerged. This theorem states that a situation could exist in which an impact on the commodity prices in a country could raise real returns to the factors used intensively in an industry where prices are rising and could lower real returns to the factors in an industry where prices are decreasing, regardless of the preferences of sellers and consumers (Lindert et al., 1996; Parrish, 2004). Even after a number of theorems attempted to intensify the defence of comparative advantage in the H-O model, a number of problems prevailed. As with the classical theories, the H-O model suffered from a similar problem in its basic assumptions. Again, one of the assumptions of concern is that countries use the same technologies and that the influence of technological change on trade and specialisation does. 11.

(24) not feature at all in the H-O theory. This contradicts the technological gap theory,5 which notes that technology differs across countries. However, despite the challenges, Bhagwati (2002) argues that if an open economy allows for market-determined allocations of resources and if prices reflect social costs, Adam Smith’s invisible hand can be trusted to guide the world economy to efficiency. In terms of this view, free trade can be argued to be the best policy. Balassa’s theory of revealed comparative advantage later emerged in criticism of the H-O theory of comparative advantage. Balassa (1965) assumed that with protective pressures such as tariffs and quantitative restrictions on trade, which trading nations frequently impose, trade should be valuable in reflecting international differences in relative costs and non-price factors. He maintained that differences in relative costs and non-price factors are reflected in the patterns of trade in the sectors assumed to ‘reveal’ the comparative advantage of trading nations. According to Balassa (1965), former theories overlooked non-price variables, such as quality differences, goodwill, servicing, the existence of repair facilities and differences in weights and measures, all of which have a significant bearing on international trade patterns in developed countries. The value of using comparative advantage as a concept for evaluating patterns of trade is widely accepted and is often featured in theoretical and policy discussions. However, measuring a country’s comparative advantage in a particular commodity is difficult (Balassa, 1965). Revealed comparative advantage (RCA) indicates the contribution of each sector to a country's overall trade balance. Various attempts have been made at providing indirect approximations of this concept, using information derived from, or revealed by, post-trade situations and assumptions about the relationships between observable and unobservable variables (Greenaway & Milner, 1993). Revealed comparative advantage shows that developing countries’ comparative advantage is limited to simple processing as it relates to agriculture or other resource-intensive primary activities (Greenaway et al., 1993). Such a limitation raises concerns about the share of agricultural trade that these countries enjoy in world trade. Using observed trade patterns to identify comparative advantage is problematic because in reality, such trade flows are often distorted by government policies and 5 Trade can be influenced by the availability of technology in one country and the nonavailability of it in. another country, which can give the former a short-term comparative advantage. There is a lag in reaction time before other countries acquire such knowledge, which means that by the time they do, the innovative country might have invested in discovering other new technology.. 12.

(25) interventions. This is particularly the case in agriculture, where government support of the sector and explicit use of import restrictions and export subsidies distort trade. Government subsidies to agriculture distort the indices of revealed comparative advantage. Thus, using revealed trade performance to show comparative advantage has an obvious drawback in that policy-induced barriers to trade affect actual trade flows (Greenaway et al., 1993). Comparative advantage is difficult to estimate, due to the non-observability of autarkic prices. The assumption that Balassa’s (1965) theory of revealed comparative advantage made is that trade patterns of comparative advantage could be observed in authentic post-trade data. This resulted in his inability to capture the effect of government intervention in terms of the theory of comparative advantage. Consequently, economists agree that, at least theoretically, within international trade, liberalised trade will cause some sectors to benefit while others will suffer a loss. 2.2.2. •. Shortfalls of free trade theories. Shafaeddin (2000) asserts that theories in favour of free trade do not argue that free trade is the best trade policy; instead, they argue that, given certain conditions, free trade is the best trade policy. Samuelson (1938) reiterates that free trade theories argue that free trade is better than no trade, but they do not suggest that free trade is the optimum trade policy for all countries. Samuelson (1938) further claims that it is not necessarily true that free trade is, in fact, the best trading policy.. •. The fundamental point of departure of free trade theories involves the concept of general equilibrium, and the general equilibrium is questioned. The critiques of free trade theory question a number of assumptions concerning general equilibrium (Shafaeddin, 2000).. •. Another reason why free trade theories fail to persuade some economists is the neoclassical theory of comparative advantage. This theory predicts that gains from trade maximise the welfare of all those in the countries concerned and that a situation of free trade inevitably leads to a situation of economic prosperity (Bender & Li, 2002).. 2.2.3. Strengths of free trade theories. Liberalised trade plays an important role in world economics and social welfare (Ackerman, 2001). Ackerman uses the example of aluminium and bananas and argues that even in. 13.

(26) countries that do not produce bananas, people do eat bananas, and people drive aluminiummade cars in countries that do not produce aluminium. He further states that the main problem with economists who favour comparative advantage is that they view free trade as a truth that fits all situations. Another point worth noting is that liberalisation policy on its own is not enough and if there are no other policies to complement it, it will fail. This calls for a relook at a number of attributes by the trade theories in favour of free trade. The economic development of the developed world was achieved through a number of policy interventions and not only through trade liberalisation (free trade). These interventions included setting up tariffs and picking and supporting key sectors. Development through a pure form of free trade only occurred in parts of Hong Kong and Switzerland. Facchini et al. (2001) argue that free trade can have positive or negative effects on different sectors within a country or among countries. The same can be said about the protectionist approach. The basic decision behind choosing a negotiating policy, therefore, will be to discern between the positive and negative effects that result from free trade. Free trade is often thought of as a good policy option for a number of reasons. For example, the fundamental benefits resulting from free trade are the positive production and consumption efficiency gains expressed in general equilibrium analysis. These gains accrue to a country when it moves from not trading to free trade. Production efficiency improvements indicate the amount by which a country can increase its production while using the same resources. These efficiency improvements occur when allocated resources lead to a shift from less comparative sectors to comparative sectors of the economy, thus increasing the productivity of the economy. It is clear that these efficiency gains imply that some sectors will expand while others will contract (Facchini et al., 2001). Trade models suggest that total production in a particular country will rise if the resources used in production shift from one sector to the other. This would cause increases in the country’s GDP. Therefore, free trade would have caused an increase in the level of the country’s national output and income. Consumption efficiency expansion occurs on an individual basis when changes in the relative prices of commodities allow consumers to achieve a higher level of utility. Since changes in prices give consumers more choice, consumption efficiency implies that choices that are more satisfying become available. When numerous varieties of commodities are available within a product category, consumption efficiency implies that consumers are able to consume greater varieties and are able to purchase a product or service that is closer to their. 14.

(27) highest possible utility curve (Facchini et al., 2001). A consumption efficiency increase is easy to describe for an individual consumer but it is much more difficult to describe conceptually in terms of the aggregate economy. Nevertheless, the aggregate indifference curves resulting from individual indifference curves can be used to describe community or societal gains resulting from trade liberalisation; it is possible to portray aggregate consumption efficiency improvements. However, it is necessary to note that the use of an aggregate indifference curve generally involves two assumptions. Firstly, all consumers have identical preferences, and, secondly, there is no redistribution of income because of the changes in the economy. Yet, international trade literature reveals that in most trade models, income redistribution does in fact occur as an economy moves towards free trade (Facchini et al., 2001). Despite the shortfalls highlighted in the previous section, it can be seen that while free trade may be ideal for countries, it does pose numerous challenges. Therefore, agricultural trade liberalisation is clearly relevant and important; however, one must bear in mind the shortfalls, such as adjustment costs, that are discussed in the following section.. 2.3. Adjustments to trade liberalisation (free trade). Blandford et al (2005) define adjustment as the process undertaken by farms, households and firms to adapt to a new policy framework. It is possible that the adaptation process will prove to be worthless or otherwise. Such adjustments include production, factor allocation and management decisions. This definition can be altered to include the process undertaken to mitigate the unfavourable effects that may arise with liberalisation while maximising the favourable effects. Although trade liberalisation is valuable and necessary in achieving free trade status, it has undesirable outcomes for developing countries and least developed countries (LDCs). The long-term benefits of free trade are desirable for all world economies, but unfortunately it has not been well recognised and documented that in the short to medium term certain countries may experience a loss. Such losses may be due to technological gaps and the political environments in those countries. It is costly for countries to shift their production into the sectors of their comparative advantage as advocated in trade literature. In terms of equilibrium, such problems may arise because of asset specificity, bounded rationality associated with the new sectors, capacity and the costs of such a change (Bacchetta & Mario, 2003).. 15.

(28) Jean-Christopher (2003) argues that openness and integration of countries within the world economy promote growth and reduce poverty. However, policy changes often result in gains and losses accrued to different sectors of the economy. As a country responds to liberalisation by shifting its resources to the productive sectors, the cost of shifting resources may be higher or lower than the benefits in the short term. Therefore, mechanisms should be put in place to reduce the negative effects, and in situations where gains do not exist, compensation for those sectors should be awarded. Adjustments in agriculture pose a considerable challenge, however. Agriculture, like all sectors of the economy, is subject to economic and political pressure. Furthermore, agriculture seems to be rigid in nature. This is due to factor immobility and remoteness of farm resources (Blandford & Hill, 2005). Two ways of considering adjustment costs are through efficiency and equity. When the neoclassical assumption of perfect information and frictionless relocation of resources is removed or relaxed, the need for government to play a bigger role emerges. In such a situation, the welfare gain or loss will be measured in terms of output and consumption forgone as the economy moves from one point of equilibrium to the other. The justification for efficient government intervention in the adjustment process relates strongly to the existence of goods that are either unpriced or incorrectly priced in the market place. It must also be noted that the existence of imperfect competition, due to government inaction, further justifies government’s active role. There are three cases worth citing regarding adjustment policy reforms. Firstly, there was the Canadian grain one-time capital payments to farmers after the removal of transport subsidies in 1995 Secondly, there was the Australian dairy restructuring package of 2000. Thirdly, there was the financial assistance provided for day-to-day living expenses in New Zealand that farmers experiencing cash flow deficits received after the reduction of subsidies from about 36% of output to 4% (Blandford et al., 2005). The above cases give insight into the issue of adjustment costs. As can be seen from these cases, governments may need to be flexible in order to implement limited domestic and, perhaps, international compensatory policies to manage the temporary negative effects of an overall reduction in agricultural support. Such may be the case for some farmers in both developing countries and LDCs when they lose preferential market access (Hoda, 1994). Considering the significance of agricultural trade to developing countries, it is necessary to look at the impact of trade liberalisation on the agricultural economies of developing countries.. 16.

(29) 2.4. The potential effects of trade liberalisation on developing countries. The liberalisation of agricultural trade may play a vital role in improving the lives of people in developing countries. This is because agriculture plays an important role in the livelihoods of the people living in such countries, contributes a large share to their GDPs and accounts for the employment of a significant number of people. The link between agriculture and livelihood in developing countries reveals that people are dependent on agriculture. This means that government support of agriculture in developed countries has a detrimental impact on producers in the developing world (South Centre, 2007). Furthermore, subsidies in developed countries benefit consumers in developing countries, as they drive prices down.. 2.5. The role of agriculture in the development of the poor. Agriculture has a major role to play in improving the lives of the poor in the developing world. It plays three fundamental roles in reducing poverty (Nagarajan, 1999): •. It contributes to economic growth and to the quality of such growth in terms of the degree to which it benefits the poor by equitably distributing gains.. •. It is the livelihood of hundreds of millions of the world’s poorest people.. •. It remains a substantial part of most developing countries’ economies.. In Africa, the agricultural sector employs approximately two-thirds of the labour force, accounting for 37% of the gross national product (GNP) and a bigger share of exports. In South Asia, despite rapid urbanisation and economic diversification, agriculture continues to generate 27% of the GNP. Therefore, agriculture remains the most likely source of significant economic growth in many developing countries. Evidence suggests that agricultural growth and increases in agricultural productivity may be a prerequisite for broad-based sustained economic growth and development (Amani, 2004). Furthermore, the global rapid rate of urbanisation notwithstanding, an estimated 70 to 75% of the world’s poorest people, the 1.2 billion living on less than US$1 per day, live in rural areas where their livelihood largely depends upon agricultural production (Nagarajan, 1999). In addition to these, agricultural trade generates the foreign exchange needed for public services in industries such as the pharmaceutical and information technology industries. Strong agricultural growth has also been a feature of countries that have successfully reduced their levels of poverty, such as India, Bangladesh, Indonesia and China (FAO, 2001). The extent to which the poor benefit from agricultural growth, however, depends on a number of 17.

(30) factors, which include the relative importance of agriculture to the livelihood of the poor. In many parts of sub-Saharan Africa and South-East Asia, agriculture remains a key component of the livelihood strategies of the poor. Nevertheless, agricultural growth is not a universal remedy because its relative importance declines as economies grow. As the livelihood strategies of the poor diversify, for whatever reasons, agriculture becomes just one of many different forms of economic opportunity available to them. Such increases in opportunities are often the result of higher agricultural productivity.. 2.6. Conclusion. The objective of this chapter was to present theories relating to both trade liberalisation and the role played by agriculture in the economies of developing countries. It became clear that agricultural trade liberalisation policies are important for stimulating development in developing countries; nonetheless, these policies should be implemented with caution. Also, it became evident that agriculture is an important economic sector and it is the predominant livelihood of people in developing countries.. 18.

(31) CHAPTER 3: THE SEQUENCE OF AGRICULTURAL. NEGOTIATIONS OF THE WTO 3.1. Introduction. This chapter presents an overview of the sequence of agricultural negotiations of the GATT/WTO, especially the UR and the DDA. The reason for this is that agricultural trade negotiations were initially dealt with as a separate issue at the UR (Indikadahena, 2005). A brief overview of the evolution of the agricultural negotiations of the GATT, which dates back to the mid 1940s,6 is presented. Prior to the UR, the first seven rounds of negotiations of GATT saw agricultural trade forming a component of trade in goods but with special treatment. Trade literature points to this as being the cause for the lengthy duration of the UR. Despite the long time taken to conclude the round, the UR marked a historical turning point in multilateral trade negotiations. Nevertheless, its conclusion did not address all of the issues of interest to agricultural trade, and hence the Doha Round became a necessity (Indikadahena, 2005). The DDA, which is the ninth round of multilateral negotiations and is based on the work of the UR, was launched towards the end of 2001. The DDA was entitled the Doha Development Round as its purpose was to consider issues affecting poor countries (Clapp, 2006) and to focus on development and agricultural liberalisation. In terms of agricultural liberalisation, the round addressed the improvement of market access, the reduction of a wide range of tariffs with the aim of eliminating them and the reduction of both domestic and export subsidies given to farmers in developed countries. At the time, it was believed that the commitments made at the round would be met by March 2003, though this turned out not to be the case (Clapp, 2006). This means that progress in agricultural trade negotiations tends to be very slow. The fundamental objective of this chapter is to view, analyse and follow the progress of the three pillars of agricultural trade liberalisation. Secondly, it is to take a closer look at the positions of the USA, the EU, the G-20 and South Africa in approaching the DDA. To achieve these objectives, the chapter is organised as follows:. 6 It needs to be noted that South Africa was one of the 23 founding members at the launch of the first round of. multilateral negotiations in 1947. 19.

(32) •. Firstly, a brief overview of the history of agricultural negotiations and their effects is given.. •. Secondly, a discussion of the three pillars of agricultural negotiations covering in sequence the UR, the July package, the Hong Kong meeting and the collapse of the DDA (July 2006) is provided.. •. Lastly, suggestions for the way forward, if the round is reinstated, and some conclusions are offered.. 3.2. Agricultural trade negotiations before the Uruguay Round. Agricultural trade negotiations have always formed a part of multilateral trade negotiations under trade in goods, with special treatment that excludes agriculture from reduction commitments on trade distortions. This special treatment of agricultural trade has caused the present state of affairs in which agriculture is arguably among the most highly distorted sectors of multilateral trade. These distortions, unlike most other areas of international trade, exist in the form of tariffs, quotas, subsidies and other forms of agricultural support (Indikadahena, 2005). The UR of 1986–1994 was the first round to address agricultural trade distortions by including agriculture in the multilateral trade liberalisation process as an issue requiring separate negotiations. The three areas of concern identified in the UR were market access, domestic subsidies and export subsidies. Market access includes issues such as tariffs, quotas and quantitative restrictions. Domestic subsidies, such as input subsidies, subsidies on environmental issues and subsidies given for research and development, include programmes aimed at helping farmers to reduce their costs. Export subsidies, which include subsidies on transport, involve support given to farmers to export their products. It is also worth noting that issues concerning non-tariff barriers were also considered.. 3.3. The effects of the special treatment of agriculture. It is argued that the GATT policies that regulated agricultural trade before the UR produced extreme distortions in the production, consumption and trade of agricultural and food commodities. These are particularly detrimental to the terms of trade of the developing countries and the LDCs. Because of subsidies farmers receive in the developed countries there has been an increase in the supply of agricultural commodities on the world markets, thereby depressing world prices (Diaz-Bonilla, Robinson & Thomas, 2002). On the other hand, if domestic and export subsidies are reduced the world prices of agricultural commodities will increase because reduced supplies of commodities will cause the world 20.

(33) prices to increase. It needs to be understood, however, that a possible tariff reduction will have a different effect on world prices than subsidy reductions. The reason for this is that a tariff imposed on any commodity increases the cost of that commodity, resulting in increased prices (Diaz-Bonilla et al., 2002). The magnitude of world price changes, which overall are expected to increase, will be determined by the extent of the support (domestic and export subsidies) and protection (tariffs) provided. Logically, the more support and protection are provided, the greater the magnitude of change will be. In summary, it is argued that world prices will increase by approximately 12% relative to the index of other prices if all agricultural trade distortions (domestic and export subsidies and tariffs) are removed. Such an increase in world prices may negatively affect the net importers of agricultural commodities, most of which are developing countries. The reason for this is that an increase in the cost of importing will translate into an increase in the domestic prices of imports. It is important to note that such domestic price increases will affect food security (Diao & Dorosh, 2003). It is necessary to distinguish which of the three pillars distorts trade the most or will account for the biggest proportion of the possible 12% world price increase (Diao et al., 2003). It was indicated that domestic subsidies account for 4% of world prices depression and that export subsidies depress world prices by 1.5%. The highly supported commodities include sugar, pork, beef and poultry (FAPRI, 2005). However, it is worth looking at the different pillars of agricultural trade.. 3.4. The three major areas of agricultural negotiation within multilateral trade. The three pillars of agricultural trade negotiation, as outlined by the WTO, merit some attention. Opinions differ regarding the negative effects each pillar may have on developing countries, including South Africa. It is therefore important for this study to discuss these pillars in relation to both the UR and the DDA. 3.4.1. Domestic subsidies in the UR. Domestic subsidies refer to the funding that farmers receive from the government, regardless of commodity market conditions. This kind of funding is most common in the EU, Japan and the USA. It is argued that the EU, Japan and the USA account for approximately 90% of known domestic subsidies. One of the problems with domestic subsidies is that they are generally considered not to have a direct effect on the trading partners of the country 21.

(34) providing them. Any form of domestic support that directly influences commodity prices and quantities produced is regarded as detrimental (Beierle, 2002). According to Beierle (2002), there are three different boxes or descriptions of domestic subsidies: •. The amber box includes payments to farmers that are linked to quantities or prices, such as those made in the form of market support, input subsidies and direct per-unit payments.. •. The blue box is closely related to the amber box in that it entails the adoption of policies that are linked to quantities and prices while limiting production. Although exempt from any disciplinary measures, it is recognised as being trade distorting. Beierle (2002) argues that this box was created as the last compromise at the UR to allow the EU to continue with its compensatory payments. At the same time, it also allowed the USA to continue with its annual domestic support, aimed at supporting the amount of farm income used.. •. The green box includes decoupled payments to farmers made in terms of the policy goals laid out in the AoA, such as those relating to environmental protection and research and disaster relief. For such programmes to qualify for the green box they should be publicly funded and must either not distort trade at all or minimally distort trade.. The OECD aggregate measure of support was used to trace the amber box reductions. It was agreed that developed countries would have to cut their spending on this box by 20% over a six-year period, using the 1986–88 baselines. Developing countries promised to cut their spending by 13.3% over a 10-year period while LDCs did not have to reduce their subsidies. There was, however, a loophole in the commitments made with respect to the amber box. The amber box is based on total spending rather than on a product-to-product basis and this resulted in total spending declining significantly while spending on certain products increased. This scenario emerged in Iceland where the total spending on the amber box declined by 27% in 1997 while spending on milk increased by 240% (Anderson, Martin & Van Der Mensbrugghe, 2005). It is regretful to note though that even where developing countries are willing and able to grant amber box relief to their farmers, the Uruguay Round Agreements on Agriculture (URAA) only permit them to give such support if they are below the de minimis.. 22.

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